Important Factors That Affect Home Loan Interest Rate

Are you also dreaming of owning a home? Thanks to affordable home loans and PMAY (Pradhan Mantri Awas Yojana – a scheme that offers interest subsidy to low- and mid-income earners) securing a home is no longer a distant dream. In fact, quick access to funds has prompted 70% of millennials (age 28-43) to buy a house than rent. Though it has become easier to accumulate funds to buy a house, staying informed could help you manage your loans better.

Your home loan EMI consists of two components – the principal and interest amount. In this article, we have decoded factors that affect your home loan interest rate. Familiarising yourself with these key considerations can help you navigate the borrowing process more confidently Let's delve into the various factors lenders consider when determining home loan interest rates.

1. Credit Score

Banks check your credit score to determine your creditworthiness. A credit score of more than 750 is generally considered as a good credit score, while a credit score below 750 is considered poor. In case your credit score is below average, banks may charge higher interest rates. That’s because banks may label you as a ‘high-risk’ customer. Similarly, having an excellent credit score would increase your chances of securing a loan with lower interest rates.

2. Benchmark Rates

Banks have a benchmark for interest rates either in the form of MCLR (Marginal Cost of Funds-based Lending Rate) or repo rate as set by the Reserve Bank of India (RBI). In simple words, banks cannot offer interest rates below the benchmark rate. Any change in the benchmark rate can impact your home loan interest rate, provided you have taken a home loan with floating interest rate. 

3. Stability in Income 

Banks may offer lower interest rates to borrowers having a stable source of income. PSU or government employees might get preferential rates on home loans. That’s because banks prefer applicants with stable income. Having a stable income stream lowers default risk and ensures repayments would be made on time.

4. Location of the Property

If the property you plan to buy is located in a prime area with a higher resale value, banks may charge a lower interest rate. The interest could be higher for properties with low accessibility and resale value.

5. Loan Tenure

The tenure or duration of your home loan may impact the interest rate. Typically, shorter loan tenures attract lower interest rates as they pose less risk to lenders. On the other hand, longer loan tenures often come with slightly higher interest rates due to the increased repayment period. 

When opting for a shorter tenure, you will pay off the loan faster and accumulate less interest over time. However, this also means higher monthly instalments. On the other hand, longer tenures result in lower monthly payments but higher overall interest expenses.

Example:

5. Loan-to-Value Ratio

The loan-to-value (LTV) ratio is the percentage of the property's value that lenders are willing to finance through a home loan. It represents the risk exposure for lenders and directly affects the interest rates offered. A higher LTV ratio indicates a higher risk for the lender, leading to potentially higher interest rates.

Example:
If the property's value is ₹1 crore and the lender offers an LTV ratio of 80%, they will provide a loan amount of ₹80 lakh. However, if you opt for an LTV ratio of 90%, the loan amount will increase to ₹90 lakh. The higher LTV ratio increases the lender's risk in case of default and may result in higher interest rates or stricter lending conditions.

6. Loan Amount

When it comes to home loans, the loan amount you seek can impact the interest rate offered by lenders. Generally, higher loan amounts may attract higher interest rates, while smaller loans may be associated with lower rates.

7. Type of Interest Rate

Fixed-rate and floating-rate home loans have different interest structures. Fixed-rate loans typically have slightly higher interest rates compared to  rates offered by floating-rate loans. However, floating-rate loans can be more unpredictable as they change over time based on market conditions.

8. Relationship With the Lender

Maintaining a long-standing relationship with a lender can give you certain advantages when applying for a home loan. Banks often offer preferential interest rates or additional benefits to existing customers with savings accounts or fixed deposits. Additionally, being an existing customer may provide opportunities for negotiation and customised solutions based on individual financial situations.